2 Great Companies With Significant Long Term Challenges

These 2 stocks are great investments for the short term but are facing significant challenges to remain competitive over a longer time period.

Gamestop (GME) is slightly undervalued at $22 dollars a share. Shares trade at just 8 times this year’s earnings and earnings are expected to grow 10% over the next 5 years. Gamestop has a healthy balance sheet with twice as much cash as long term debt and an excellent amount of free cash flow. The stock currently sells for just 1.3 times its $17 book value. Things are looking good at Gamestop. So, what’s the problem? It’s hard to envision Gamestop’s business model being successful 10 years from now. Will people still be running to Gamestop to buy video games in 2020?

Digital distribution is the future of video gaming. There is currently an industry wide debate about the future of console gaming as costs continue to rise. The need for gaming discs will significantly decrease as downloadable content becomes increasingly available. Gamestop offers many PC games via download now but the bulk of their business comes from in store video game sales. Gamestop derives a significant portion of its revenue from reselling used games. It will be interesting to see whether Game Stop changes it business model before the shift or ignores the problem and stands pat with its current business model ala Blockbuster.

Coinstar (CSTR) is currently reaping the rewards from the popularity of its Redbox kiosks. Coinstar, the parent company of Redbox, derives 75% of its revenue from Redbox. The stock is trading at $52 per share which is about 18 times earnings. While Redbox has been successful with its $1 DVD rentals, the future of the movie industry is for digital distribution. Major movie studios are fighting back against the low cost distribution model of Redbox. Studios are already discussing offering Video On Demand rentals that would be available before DVD releases. Early delivery of content would have a direct impact on Redbox’s sales.

The studios are not alone in their fight against Redbox. Not only are their Netflix’s streaming movies but Google TV is now getting into the video on demand business. Google and Netflix are working together to bring movies via digital delivery to your home television. There is also Apple TV to consider. Redbox can’t afford to underestimate what Steve Jobs and the execs at Apple are dreaming up at 1 Infinite Loop.

Disclosure: I do not own any shares in either company. 

Photo by: Andres Rueda